ASIC attack on hybrids a case of too much, too late: Morningstar

Research house Morningstar has come to the defence of hybrids – sort of – following a stinging critique of the quasi fixed income instruments by the outgoing head of Australia’s financial regulator.

In a note published last Friday, John Likos, Morningstar Australia senior credit analyst, says press comments by Greg Medcraft, Australian Securities and Investments Commission (ASIC) chairman, labeling hybrids as “ridiculous” for retail investors was an extreme reaction.

“We are by no means flag bearers for hybrid securities, however, throwing such a blanket statement over them as an entire asset class is excessive in our view,” Likos says. “Hybrid securities can generate attractive income streams for those able to understand and willing to take on the risks.”

Medcraft, due to exit ASIC this November after almost seven years in the role, told the Australian Financial Review last week that the roughly $28 billion of hybrid notes issued to date by country’s major banks would eventually cause systemic problems.

However, Likos says the timing of Medcraft’s comments was “a little intriguing”.

“Hybrid risks have been a hotly discussed topic among market analysts in recent years, however, ASIC has remained relatively quiet on this topic recently,” he says in the note. “This is even more surprising now the veracity of Medcraft’s views have been laid bare.”

Likos says ASIC should have been more active in educating investors on hybrids if the regulator had identified such risks.

The Morningstar note also debunks Medcraft’s claim that hybrids were banks’ “first line of defence” against trouble, pointing out that shareholders take the initial hit.

Furthermore, Likos says the ASIC chair’s comparison with the UK, where hybrids are banned for retail investors, was problematic given substantial technical differences between the security type in the two regimes.

Nonetheless, he says the research house agreed with Medcraft’s core point about the lack of retail investor understanding of hybrids – commonly marketed to investors, both here and in Australia, as low-risk instruments.

“At Morningstar, we continually reiterate our view hybrid securities are not substitutes for fixed income securities or term deposits,” Likos says. “We believe they should be treated as a separate asset class with their own asset allocation. In our view, hybrid securities should only be the domain of the medium to high risk investor as part of a diversified portfolio.”